Make It Last – Ep 14 – Avoiding Hidden Investment Fees

The stock market is doing great, so people don’t often pay attention to the amount they’re paying in fees. This week, we’ll cover the different kind of investment fees that exist and how to check your fees to make sure you’re not paying too much.

Make It Last with Victor Medina is hosted by Victor J. Medina, an estate planning and elder law attorney and Certified Financial Planner™. Through his law firm and independent registered investment advisory company, Victor provides 360º Wealth Protection Strategies for individuals in or nearing retirement.

Bert: Welcome to “Make It Last,” helping you keep your legal ducks in a row and your nest egg secure with your host, Victor Medina, an estate planning and elder law attorney and certified financial planner.

Victor J. Medina: Hey, everybody. Welcome back to Make It Last. Thank you for joining us this Saturday morning. I am so happy to be with you. As the announcer said, my name is Victor Medina. I am the host of Make It Last, where we help you keep your legal ducks in a row and your financial nest egg secure. I’m excited for today’s show.

It’s one of my favorite topics to talk about. We’re going to spend the segments two and three talking about investment fees. Every time I give this presentation to a group, their eyes open wide because, for the first time, they’re being explained and taught how much they’re paying in investments.

I’m very excited for that, and I can’t wait to share that information with you. Before we get started on that, I wanted to talk a little bit about a cautionary tale. As you know, I have two professional hats that I wear.

When I’m not hosting this radio show, when you’re not joining us these lovely Saturday mornings listening to this show, I’m an estate planning attorney with an elder law focus, as well as a certified financial planner.

I wish that the majority of our clients came in with lots of time to plan and good health circumstances, basically not in crisis, but that’s not the case. It’s just human nature to wait until it’s almost too late to seek the help that you need. One of the things that we see a lot is that the people that come to us for help with an elder law situation, they do that really late into a process.

What they’ll do is they’ll wait until somebody’s sick or they’ll wait until somebody is in a nursing home. Then they’ll start to do the crazy research that it takes to find an elder law attorney and then somebody that can help them. They’re not often thinking with their most relaxed brain on.

They’re in crisis mode and, like any port in the storm and, they’re looking to somebody that’s going to be able to help them. Many times, we’ll meet them because we’ll have done work for a family and they’ll come across that family and say, “Well, who did you use?” and they’ll recommend our services.

We’ll see a lot of people referred to us for planning in crisis where we’re meeting them after an event has occurred. That’s late. The cautionary tale I wanted to share with you is about a client family that came in to see us pretty late into a process. I often will meet with the healthy spouse of an older couple, where one of them is starting to face some dementia problems. That was this family.

It happens most of the time. It just happens, I guess, in my practice. Most of the time, it’s the husband that’s sick and the wife that’s taking care of him. It gets to a point where they can’t take it any longer, and they’ll come in and see us.

I met this family. I always call them mom. It’s the wife, I guess. [laughs] Mom is dealing with dad, and dad has started to take on behaviors that threaten mom. He’d gotten a little bit more violent, wandering, not really paying attention to whether the gas stove is off. It’s dangerous.

They’re coming because they now realize that they need the next level of whatever care that is. They start to see the bills that are associated with that and they realize it’s really expensive. They’d like to save some money if they can. They realize they might spend it all, so they come in and see us.

In this case, as I said, dad had gotten a little violent. It was a very sad situation, because I’m certain that this had never gone on in their life before. Mom had never called the cops on dad, on her husband, because he just wasn’t a violent type.

Because of the dementia ‑‑ we can read all kinds of things into this ‑‑ maybe his frustration at dealing with not knowing what’s going on, he had gotten a little bit more physical and we needed the police to separate them.

In fact, they had called the cops a little bit before, and they were working on a very short time frame to find a facility to put dad into and then think about the rest of the planning. How were they going to save any money or do anything to help protect assets and keep up a good quality of life for mom?

The cautionary tale is really about the idea that too often we remain blind to what could be coming around the corner. We think that it’s not going to happen to us, that no matter what story we’re being told, that people get sick, and when they get sick the care gets expensive. No matter what that story is, we rationalize the idea that it’s not going to happen to us.

We stick our heads in the sand and we don’t take what could be preventative action. What I didn’t tell you about this family is that it wasn’t the first time that we had seen them. The first time that we saw them was two years earlier when dad was a little bit more with it.

We were explaining what the options were, explaining to them the need to have a plan in place to deal with the contingencies that might come up later. They decided not to move forward at that time with our planning services, that they would think about it or wait on it.

Quite honestly, it was a couple years ago, and we see so many clients I don’t really remember what their answer was to us about why they didn’t move forward, but they didn’t. It saddened me as somebody who cares about what happens to our clients.

I know that if we had had the opportunity to talk to them and move forward with a plan, then as dad’s care needs increased, as he got worse, we would have been able to deal with it because we would have had the plan in place about what to do next.

This cautionary tale is a plea. It’s a plea to everyone who’s listening. If you know of a family, or if you’re currently facing something that’s related to this kind of elder care planning, these long‑term care costs, please, please, please go and visit with somebody who specializes in elder law. Visit with them and follow through on their recommendations.

As an elder law attorney, I’ve seen over a thousand cases and I know what’s coming around the corner. If I’m making recommendations about what to do to help plan for this, I’m doing it because I’m really concerned about your best interest. I want to make sure that you don’t have problems in the future, and this is one of the ways to do that.

If you’re in that situation, reach out to an elder law attorney. If you know of somebody who’s in that situation because you know what’s going on with the family, take the steps to talk to them. Really help them understand where the value would be in putting a plan together, because we don’t know what’s coming tomorrow.

What the status of tomorrow is isn’t promised. Being able to put a roadmap in place that thinks about different kinds of situations, and helps put a plan together will only benefit you. It’s always harder to do that kind of planning when you’re in a crisis trying to figure that.

Victor: All right, enough. We’re going to take a break right now and when we come back, we’re going to talk about investment fees. I’ve already told you it’s one of my favorite topics to talk [laughs] about, so I’m going to get really excited about it. Stay tuned, we’ll be back right after this break.

Victor: All right. Welcome back to Make It Last. Today we’re going to be talking about investments fees. Specifically, the fees that your broker, your investment advisor, or, in your investments, the hidden fees that we might not know about. I’m going to cover three areas of fees. I need you to understand that this is not all of them. We’re going cover as much of them as we can.

We only got two segments and about 17 minutes to go through it. When we think about that, I want you to realize that these aren’t all of your fees. It is important to go through them, at least these three, because even this can be eye‑opening for you.

When I meet with clients, one of the first steps that we take in valuing their investments is to look at the expense ratios of the portfolios that they’ve put together. Very often, what we have found is that the investments that they’re in are expensive for what they’re doing.

They’re expensive overall, but they’re certainly expensive for a passive investment strategy, so it’s important to go through that. We’re going to cover three areas. The first area we’re going talk about, advisor fees. What do advisors charge? How do they get compensated? Expense ratios, which are part of mutual fund fees, and the fees that are associated with the variable annuity.

Now, if you have read my book, “Make It Last ‑‑ Ensuring Your Nest Egg Is Around As Long As You Are,” that’s the one with the blue cover, it talks about finances in retirement, then you know that I hate, hate, hate variable annuities. I have called them, in the book, the scourge of the earth. I’m going to talk to you a little bit about why in this very important show.

We’re going to talk about that, advisor fees, expense ratios, variable annuity fees. Let’s go with advisor fees. Advisors are compensated, primarily, one of two ways. Either they are a commissions‑based advisor or they are a fee‑based or fee‑only advisor. In a commission‑based advisor, the advisor is paid in the form of commissions for investments that you are in.

You, as the client, put your money with this big brokerage house. The brokerage house pays the advisor. That means that that advisor can recommend, and often does, investments that pay them out more, but which may not be in your best interest because they’re getting paid a commission as a percentage of the investments that you’re in.

Imagine, in these big, big investment houses, the ones that all start with the letter M, and they got the big bulls on the outside, right? They have a menu of investments that they’re recommending to their advisors to recommend to their clients. In these investments there are payout grids which tell them how they make more money on certain investments every month.

Those investments might change and the payout for them might change. Basically, the advisor’s being incentivized to sell particular things because they make money as a percentage of the commissions, it’s a commission on what they are selling. That’s also the case, for instance, if they’re primarily an insurance agent.

I’ve already talked about this. The whole world about financial advisors is that anybody can call themselves a financial advisor. They could have just an insurance license and they’re still a financial advisor, but miraculously, miraculously every solution has to do with insurance. Got to buy this annuity product, got to buy this life insurance.

They can’t cover everything because they’re not licensed to cover everything, but they get paid on commissions and so they’re going to sell the thing that pays them because they got to pay the mortgage when they get home.

Anyway, commissions‑based advisors, whether they’re in a brokerage house or they’re insurance people, those are the folks that get paid based on what they recommend. Their pay can go up or down based on the commissions that are paid out on that.

Now, if you contrast that with a fee‑only advisor, a fee‑only advisor is someone who gets paid regardless of the financial products that you are in. They work directly for you. You pay them. You pay them. They charge a fee. They could charge a flat rate. They could charge a retainer on a monthly basis or they could charge a percentage of the assets under management.

The way that we do things, we charge a percentage of the assets under management. We think that that’s fair because our fates are tied to those of our clients. If the cap value goes up, we get paid more. If the cap value goes down, we get paid less, but we are in line with our client’s best interest by charging a percentage for the assets that we’re managing.

It doesn’t matter what we recommend. It’s in our best interest to recommend the thing that is best for our clients. In fact, it’s in our best interest to recommend the least expensive thing for our clients because, if the funds themselves don’t take money out to pay themselves, then there’ll be more money in the account. We’ll be incentivized because we’ll be getting more money out of that.

A fee‑only advisor doesn’t have any incentive to sell any particular financial products. They work for you and not the investment company. That gives them the opportunity to recommend just about everything.

There’s another reason why someone who works on a fee basis is preferable to somebody who works on a commission basis, because someone who makes on a commission basis, they are incentivized. They earn a commission on every transaction. Whether you buy or sell something, they’ll make a commission. Whether or not the investment goes up, or down, or sideways, they’ll make a commission.

Sometimes ‑‑ this is illegal, but it’s very hard to find ‑‑ they’ll make a commission when they make you move sideways. It’s called churning, where they just sell something to make a commission.

If you’re finding yourself in a situation where you get called routinely about making an investment change, you got to think about whether or not this person’s getting paid as a function of the commissions that they’re receiving for making those investments.

I have one other topic to cover on this, and it is partly related to the expense ratios ‑‑ before we get to the break. There are also commissions embedded in the investments that you have. If you have a mutual fund, that mutual fund may have multiple classes of shares. You’ll be able to see it on your statement.

You might see a share class of I. Let’s say I afterwards, that’s institutional. You might see A or C. When you look at those A or C share classes, what you’re seeing in there are hints about what kind of commissions might be embedded. Typically, institutional shares don’t have any commissions ‑‑ which they call sales charge, but it’s a commission ‑‑ for the sale of that particular share.

An A share might come with a four or five percent commission up front and an ongoing trail commission that’s payable to the advisor. It comes out of the investment, but you never see it because it goes directly from the investment company to the advisor. All you see is that your money’s gone up or down.

By the way, it may not have gone up as much as you would have expected it to because it got siphoned off for these fees. The problem in a great economy ‑‑ as we’re doing right now, like in the stock market, it’s gone up ‑‑ is that you see your account value go up, but you don’t realize how much more it could have gone up if there weren’t the expenses associated with that particular investment.

What I want you to do before we take a break, or at least write it down to do later, is I want you to go find your investment statement. If you have that investment statement open, look at the mutual fund shares that you’re in, and take a look at the share classes.

If you see a bunch of As and Cs in there, you know that you own investments that paid a commission to the person who sold them to you and is likely paying them an ongoing commission going forward. That might be in addition to whatever they’re charging.

Victor: That segment went by really quickly. Stick with us. When we come back from the next break we’re going to talk more about expense ratios and variable annuity fees. I hope we have enough time to get through it all. We’ll get back right after this quick break.

Victor: All right. Welcome back everybody. We are talking about your fees for investing. This is a great stock market that we’re in right now. Things keep going up, and up, and up, but could you be just a little bit richer, a little bit more money if your advisor had been recommending things that were a little less expensive for you?

We’re talking a little bit about expense ratios. Now, to do that I have to talk about mutual funds because mutual funds tend to be one of the ways, or the most popular way, for people to diversify their investments.

What they’ll do is that, rather than going out and trying to buy a bunch of stocks or a bunch of bonds and managing those individually ‑‑ in which case they may not have enough money to own enough to diversify ‑‑ they buy a mutual fund. The mutual fund goes and takes and pools all this money and they invest.

The mutual fund can have all kinds of planning philosophies. They can be just in equities, international, global. It doesn’t really matter what they do. The idea is they’ve pool together money and helped you diversify by letting you own a bunch of stuff as part of one set of investments.

They have operating costs. Those operating costs are reflected in the value of the shares that you own. It might go up or down based on the amount of money that it takes to run those. The expense ratio is actually something that’s published. You can go to Morningstar and you can put in the ticker symbol for the mutual fund, and it will tell you what the expense ratio is.

What they do is they give you a percentage. That percentage is a function of an annual fee that gets taken out in order for them to run their investments. There is a study from DALBAR. DALBAR is one of these objective agencies that goes ahead and does studies on investor behavior and things like that. They concluded that the average mutual fund fee was 1.44 percent.

We’ll just use that number for our example. This is the number that I use in my presentations and my seminars. When we do investing, the maximum average fee ‑‑ the weighted fee when we put somebody in the most expensive portfolio ‑‑ the maximum of that fee is about 0.33 percent annually. It’s almost 1.1 percent savings on an annual basis.

What’s the effect of that? I’m going to talk about some numbers. I don’t want you to get lost in the numbers, but when you invest money over time, because the fees are drawn out annually it limits the amount of money you can make because you’re not compounding on the growth if there’s persistent growth.

If I take a percentage off, one full point off of that, and I take it out as operating expenses, then you don’t have that money to then grow to the next amount because this is part of the concept of compounding.

What I did is I just illustrated for purposes of education what would the difference be if you had a portfolio made up of just a weighted average mutual fund, 1.44 percent, versus the most expensive fund family that we put together, and that’s 0.33 percent?

The difference is staggering. If you invested over the course of 10 years and just got the same average return, about seven percent on average, if you invested $10,000 for 10 years and you have the more expensive portfolio, then you would have kept 73 percent of your money.

If you had gone ahead and invested that with a 0.33 percent, then it would have helped you keep 93 percent of your money. 93 percent of your money would have been kept. That’s a 20 percent difference. You would have kept 20 percent more in that. Now, I think that that is amazing. Amazing.

The reason why you might have been in the more expensive funds is because it pays the advisor extra money. They were making those recommendations because the more expensive fund shares a portion of those operating expenses with them.

Sometimes the more expensive fund is just doing things that aren’t what we consider to be smart investing. They do more active trading. They’re following an index and just chasing money and it costs more money to do that. The idea here is that, if you’re following this evidence‑based investing, which is a little bit of what we do, you know that you want to keep the expenses low on that.

If you’re acting as a fiduciary for your clients, as we do, then you know that it’s not in their best interest to take commissions on ongoing expenses and then charge them a fee on top of that. That just doesn’t work. It’s really important to keep those expense ratios low because, as we’ve seen when we run the numbers, in fact, it helps you keep more of your money.

Within the context of a variable annuity ‑‑ because I’m running out of time here ‑‑ within the variable annuity, it’s very similar. Very similar to the expense ratio discussion because one of the problems of a variable annuity is that there are fees that are embedded as part of the contract.

Someone might be selling you a variable annuity. It’s got this income rider, there’s a tax deferral, and they’ve got this whole conversation that they want to have with you on a variable annuity. What they fail to talk to you about is that inside of the variable annuity there are fairly significant fees.

One of those fees can be what’s called a mortality and expense charge. That’s the cost, essentially, of insurance because variable annuities are issued by insurance companies. They will wrap that in an insurance wrapper and that wrapper will cost up to one percent annually.

Then there’s an administration charge or a contract fee. That might get the number to one‑and‑a‑half percent. Then, on top of that, there might be a rider fee for you to have the extra investments for income benefit or something like that. That might be one or two percent.

Then, on top of that, there are fees for the investments inside the variable annuities. They say, “OK, you got to invest from this. It’s a conservative growth plus income,” but those mutual funds themselves have operating expenses.

When I’ve analyzed variable annuities ‑‑ I probably just should give a whole show on this ‑‑ we see that there’s probably three to four percent annually coming out on fees. That takes a significant bite out of the performance of these investment vehicles that could otherwise be doing well.

The fees that I talked about today are fees that you can look up. There are hidden fees, too, that are very difficult to talk about, trading costs, things like that, bid‑ask price, some stuff that would get your eyes to roll in the back of your head.

The expense ratio, the mortality and expense fees that are part of a variable annuity, your advisor fees ‑‑ if they’re charging you something or not ‑‑ those are all things that you can look up on your own and figure out how much you’re paying.

There’s some number that’s going to seem to make sense, but here’s the point. You should know what you’re paying for your investments. It should be crystal clear what you’re paying whether that’s high, low, what the numbers are, and, in fact, it should be in black and white like something that…

When we put a portfolio out ‑‑ we just closed in the quarter here ‑‑ the statement that comes out talks about each one of the fees, our fees, the expense ratio fees. It’s all listed in there and we’re super transparent about it.

You deserve to know more about the investments that you have because you could be making more money when it comes to this if you are a little bit wiser about those investments. All right? Go do that. Either talk to somebody that’s a fiduciary. Call us or something like that, or go look it up on your own. Go to the Morningstar and figure it out, but go figure out what your investments cost.

It is important enough for you to do that. Boy, we have run out of time. I’m going to spend a whole other show on variable annuities and just to talk about those. It’ll be a little bit of a recap, but these are important, too, because they get sold and oversold. I just don’t like them at all. I hate ending on a down note, [laughs] but we’ll do it. We’ll talk about variable annuities.

Thanks for listening today. Thanks to the production crew for making us sound so good. If you like this show, please do me a favor and go on to iTunes and leave us a great review. It really helps the rankings on that.

Victor: Share this show with friends. We know that there are people out there listening. Tell them about the iTunes link. Send them to the website and have them listen to this. This is a great one for them to get introduced to because it helps them learn more about their investments.

Share this information widely. I think the more people know about it the more people will be able to help control their future. I think that’s important. Anyway, thanks for listening to Make It Last. We help keep your legal ducks in a row and your financial nest egg secure. I will catch you next Saturday. Thanks so much. Bye‑bye.

Bert: The foregoing content reflects the opinions of Medina Law Group, LLC and Private Client Capital Group, LLC and is subject to change at any time without notice. Content provided herein is for informational purposes only and should not be used or construed as investment or legal advice, or a recommendation regarding the purchase or sale of any security, or to follow any legal strategy.

There is no guarantee that the strategies, statements, opinions, or forecasts provided herein will prove to be correct. Past performance is not a guarantee of future results. Indices are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses which would reduce returns.

All investing involves risk, including the potential for loss of principal. There’s no guarantee that any investment plan or strategy will be successful. We recommend that you consult with a professional dedicated to your needs.